Abusive Overdraft Loans

Accidentally overdrawing your bank account, whether because of a bounced check, an ATM withdrawal or a regular purchase, can lead to costly bank charges.

Many people accept these charges, sometimes assuming that they're simple Not-Sufficient Funds (NSF) charges banks can use as a deterrent for overspending, and sometimes in an effort to repair their credit after filing bankruptcy.

But the Center for Responsible Lending found in a recent study that a change has occurred in the banking industry. Today, 69% of overdraft charges are considered "abusive," and they're costing consumers billions of dollars each year.

What Are Abusive Overdraft Loans?

The Center for Responsible Lending describes Abusive Overdraft Loans as small, expensive loans made by a credit institution or bank to a customer who has a negative balance in his account. Sometimes falsely called "bounce protection," these loans take a fee from the borrower's next deposit to cover the "service." Banks often offer this service without the borrower's consent or knowledge, and without informing the borrower about less-expensive methods of overdraft protection available.

These loans ultimately serve as income-generators for banks, and are becoming increasingly lucrative. In 2005, banks made an estimated $10.3 billion in abusive overdraft loans. By 2006, the total was $17.5 billion.

While these numbers are eye-opening by themselves, what's more shocking is this: the loan amounts totaled only $15.8 billion dollars, meaning that banks' overdraft fees are greater than the amount of money loaned.

These fees have become a significant source of revenue for banks - in 2006, 40% of banks' total income came from abusive overdraft loans. And here's why.

Bank Practices that Facilitate Abuse Overdraft Loans

In the past, many banks used NSF funds to discourage consumers from spending money they didn't have. In most cases, if a consumer wrote a check that bounced, the bank would charge an NSF fee and deny payment to whoever tried to cash the check.

Today, most banks have abandoned NSF charges in favor of abusive overdraft fees. Often, the practice is labeled "overdraft protection," but it can actually cost the borrower much more than traditional overdraft protection practices.

Abusive Withdrawal Practices

Specifically, research shows that the average purchase that results in automatic overdraft fees costs $27. The average abusive overdraft fee, though, is $34! This means that on average, each dollar of an overdraft purchase costs the buyer $1.26 in fees-and it gets worse.

Most banks reserve the right to manipulate the order in which they remove funds from an account, based on transactions made. This can mean that, if you make a large payment (like a rent check) at the end of the day, following several smaller transactions (lunch, coffee, groceries, etc.), banks can-and often do-remove the larger amount first.

This means that your account has a better chance of becoming overdrawn, and that, if it does, you'll be charged overdraft fees for EVERY OTHER TRANSACTION, even if they were made at a time when you actually had enough money in your account to cover them. When each overdraft purchase costs $34, little purchases add up quickly, and a $2 drink can cost you almost $40 in fees.

Further harming consumers, in 2004, new banking regulations allowed for checks to clear faster, meaning that the dollars included in the checks you write can now whiz out of your account more quickly than ever.

Abusive Deposit Practices

In addition to the manipulation of funds removed from your checking account, banks often delay putting money into your accounts, so that funds aren't available until several days after they're deposited.

Banks are legally allowed a certain number of days to process deposits, and they often use all that time, even if they don't need it to put funds in the account. This increases the chances that you'll overdraw your account, especially if you assume funds have cleared and been deposited.

The Hidden Costs of Debit Cards

In the past few years, debit cards have grown in popularity because of their versatility and convenience. Banks have noticed this, and have taken advantage of the trend.

Once upon a time, if you tried to make a debit card purchase or withdrawal from an ATM with insufficient funds, you were denied at the register or machine. Now, though, most banks will let your transaction go through-without notifying you or giving you the choice of canceling it!

For each overcharge on the debit card, banks charge the same flat fee they charge for other overdraft purchases-around $34. This is especially harmful for frequent debit-card users because the average debit card purchase that results in overdraft fees is only around $17, meaning that for each dollar spent, the borrower has to pay $1.94 in overdraft fees!

Preventative Measures You Can Take

Protect against overdraft fees by linking your checking account to your savings account or a credit card with a reasonable interest rate. With this protection in place, any overdrafts will be covered by your own money or a line of credit at an established, known rate.

Be sure to understand all the terms of your bank account. If you're opening a new account, ask about the bank's overdraft policy. If you already have an account, challenge any inconsistencies you see-like if your purchases are processed in an order other than the one in which you made them.

Ask for quicker credit. If you think your bank is taking too long to make your funds available, ask them what they can do. One bank manager has admitted that his policy is to hold funds as long as possible unless a client complains.

Look for options. Some banks alert consumers when they're about to overdraw their accounts, and some will do so if the consumer specifically requests this treatment. Make sure abusive overdraft fees never take you by surprise.

Avoiding Abusive Overdraft Loans After Bankruptcy

The Center for Responsible lending has noted that today, the majority (69%) of overdraft loans are abusive. The various techniques used by banks to maximize their revenue can serve to plunge you into debt and make it difficult for you to escape.

With the prevalence of ATM and debit card usage, in addition to regular check-writing, banks have more opportunities than ever to charge you overdraft fees. Especially, if you're trying to rebuild your credit after bankruptcy, it's important to be aware of these practices, so that you can avoid them.

The above summary of abusive overdraft loans is by no means all-inclusive and is not legal advice. For the latest information on avoiding abusive overdraft loans, speak to your bank or an attorney in your area.